WASHINGTON, October 9, 2010 –Economic recovery is underway in theMiddle East and North Africa region (MENA) though below historical trends and the economic potential of the region. Its economic prospects depend on global developments and continued strengths in emerging-market demand and oil price trends.

“Sound macro-economic management and a prudential approach to financial sector regulation has helped MENA countries escape a severe recession,”said Shamshad Akhtar, Vice President of the Middle East and North Africa region (MNA) at the World Bank.“Now the key challenge is to sustain growth after the rebound. For this the region can harness the strong human and physical resource base it has invested in over the past decades.”

The diagnosis presented in the latest Regional Economic Outlook: MENA Sustaining the Recovery in Times of Uncertainty, presented by the World Bank today, suggests that while MENA is recovering, the pace has been less vigorous than the recovery in other developing regions. Growth in the region is expected to average 4% in 2010, an increase of slightly less than 2 percentage points (pp) over growth in 2009 and weak compared to increases of 5.6pp in advanced economies and 4.5pp in developing nations. Only by 2011 and 2012 is MENA’s growth expected to return to the average rates achieved prior to the economic and financial crisis.

“The factors constraining the regional recovery are present to different extents in the three major groups of countries in the region – the oil-exporting countries of the Gulf Cooperation Council (GCC), developing oil exporters and the oil importers,”saidElena Ianchovichina, principal author of the report and lead economist in the MNA region at the World Bank.

The well-integrated GCC economies (Saudi Arabia, Kuwait, Bahrain, Qatar, United Arab Emirates, and Oman) were hardest hit by the crisis, but they recovered quickly as oil demand rebounded thanks to Asian emerging markets, and as the financial sector stabilized. In 2010 growth has been constrained by weak credit expansion, and by the fact that some GCC countries had to restrain output to support oil prices. In 2010, economic growth for the GCC group is projected at 4.2% – a strong comeback from near zero in 2009. The expectation for 2011 is 5% before a decline to 4.8% in 2012.

All GCC governments continued to stimulate their economies as the global economy started slowing in the second quarter of 2010. Weakness in oil markets due to a global slowdown is the major threat to the recovery in GCC countries, although they have fiscal space to cushion the impact of a negative terms-of-trade shocks. However, systematic reliance on government spending has risks. Some of the fiscal expansion will be self-terminating when projects are completed, but the medium-term burden of continued capital and current spending growth could increase the cost of capital for the private sector as public saving declines.Limited access to finance for small and medium enterprises (SMEs) and distortions in labor markets that discourage skill acquisition and entry into the private sector also pose a threat to the long-term growth of GCC economies.

Developing oil exporters in the region, Algeria, Iran, Iraq, Libya, Syria and Yemen, felt the impact of the crisis largely through the oil channel as their financial sectors are mostly state dominated, and not linked to global financial markets. Real growth for these countries is projected to be 2.9% in 2010, up by less than a percentage point from 2.1% in 2009, and accelerate to 4.2% in 2011, and 3.9% in 2012.

Developing oil exporters are vulnerable to sharp declines in oil prices and growing price volatility is a major problem for them. Volatility is expected in the months ahead suggesting that prudent macroeconomic and oil revenue management have become even more challenging and important.

“Critical for these economies is diversification,” said Akhtar. “They need to urgently scale up non-oil sources of growth to help reduce their vulnerability in the immediate future and in the long run.” She added that some of these countries are also vulnerable to food price shocks stemming from recent wheat price increases. Yemen stands out as the most vulnerable with Iraq only slightly less so.

Akhtar observed that developing oil exporters face deep structural issues that will continue to constrain long term growth. In response to the recent crisis, some countries had backtracked in their reform efforts and passed laws to increase protection levels (already among the highest in the world) and discriminatory treatment of firms. Others face production-related problems limiting their oil output. The nonoil export performance of these countries has also been weak relative to their potential, and in comparison with other countries, while their financial sectors have remained burdened by non-performing loans.

Oil importers like Egypt, Morocco, Tunisia, Lebanon, Jordan and Djibouti weathered the effects of the crisis better than other MENA countries, but developments in Europe and the still relatively anemic credit growth in some countries, are expected to dampen growth in 2010, especially for those with EU links. Lebanon has been the exception. The real estate and banking sectors have been booming and driving strong growth performance. Oil importers’ growth is expected to average 4.9% in 2010. Assuming steady progress with structural reforms, growth is expected to surpass pre-crisis levels and average 5.3% in 2011 and 5.7% in 2012.

Two of the oil importers with EU links – Morocco and Tunisia – have much greater trade and remittance flow exposure to the EU than Egypt and the rest of the oil importers. In anticipation of a prolonged slowdown in the EU, Morocco and Tunisia have extended or implemented new fiscal stimulus. In addition, a food price hike has become a threat to all oil importers in the region. Egypt and Morocco face the largest estimated monthly imports of wheat and thus the largest import bill increases. Stimulus has helped oil importers weather the crisis and support the recovery, but many of them are now squeezed for fiscal space which is a long-term vulnerability. With a few exceptions, reforms have broadly remained on track, giving oil importers the opportunity to continue the process of transforming their economies, upgrading their technological capabilities and improving their competitiveness.

“In the post crisis world, MENA cannot afford to lose sight of the longer-term, structural, challenges of sustained growth and job creation,”said Akhtar. “We can also not afford to be complacent about vulnerable people and the Bank is helping ten MENA countries with well-targeted social safety nets, reform of subsidies and fiscally efficient social insurance programs.”